Levels Of Risk In Equity Portfolio Investments: Risks vs Benefits

by humagaia

Determining levels of risk and balancing them against benefits is essential in developing an effective and profitable, balanced and diversified, equity portfolio.

Risks versus benefits: the eternal balancing act. A little extra on one side changes the whole. Equity portfolio investments are all about the companies. Extract the information you need to determine which of many is the best in which to invest within the sector you have chosen. It is only valid if you compare like for like, so that the levels of risk and benefits are based on similarity rather than difference. Management, clients, suppliers, products, workforce are all factors to consider. Once considered, a watchful eye must be kept upon any changes that take place, so that a quick response can be undertaken. Don't stick with what you have invested in, just because it was the best investment at the time - that can change quickly.

Level Of Risk

Equity investment - comparing levels of risk

Do investments of a similar kind have the same levels of risk?

Certainly it is the case that some do.

But it is not the case for equities.

Buying shares in a blue chip company usually has a limited risk of company failure, although recent examples could be given of this not being the case.

However, a portfolio of blue chip companies has less risk of bankruptcy (thus losing all of your investment) than, say, a portfolio of 'junior' equities - not all of which will fail, but some could.

Each company, regardless of size, has its own unique set of circumstances that define the level of risk that you will encounter when investing in that company.

Each is a key feature that must be taken into consideration when determining the relative levels of risk between two similar companies:

  • Management - how good or bad is it?
  • Products - are they reliant on too small a list of products?
  • Clientèle - are they reliant on one or two large customers?
  • Suppliers - will the company be affected negatively if their suppliers increase prices?
  • Workforce - are they flexible enough to meet changing circumstances?
  • Flexibility - can the company itself change to meet a new sales environment?

This is not an exhaustive list, but it is a good start to make you think through the risks that may affect your investment decision.

Equity Risk

Rethinking the Equity Risk Premium

In 2001, a small group of academics and practitioners met to discuss the equity risk premium (ERP). Ten years later, in 2011, a similar discussion took place, with ...

Only $9.95

View on Amazon

Management Risk

How good or bad is the current management?

How good or bad company management affects investment risk, is the first thing to consider when analysing whether or not an investment should be made.

But how do you determine management efficiency?

One way is to look at track record.

This can be determined by the performance of the company, over time, with the same management.

Your interest lies in the dividend performance and the equity price performance. In comparison to other equities within the same sector, has the dividend and / or price performed above or below the average. Those equities that have outperformed the average could be considered to have a good (investor perspective) management. It may be in spite of the management, but at least the management has not overly limited the performance.

Another way to determine management efficiency is to look at the performance of individual management members, especially when they have arrived from other companies. 

A determinant in whether or not to invest may be when management changes. An equity in the doldrums due to management incompetences can be turned around if a competent management team is hired. Always be on the look-out for management changes and decide if it is time to move in or out of that investment.

Essentials Of Risk Management

The Essentials of Risk Management

Risk management is no longer confined solely to risk management specialists. Stakeholders ranging from employees to investors must understand how to quantify the tradeoffs of ...

$39.95  $7.34

View on Amazon

Product Risk

Is the company reliant on too small a list of products?

A company may shoot up in market price due to a successful launch of a product. However, if that company is reliant on the income from a single, or too small a diversity of, product, then it is vulnerable to the vagaries of the market. A sudden trend change can see plummeting sales and a highly uncertain future.

Do your homework and take into account the number of products that are available from that company. Check their income statements to see if any one product brings a significant proportion of income onto the bottom line.

A diversified portfolio of product offerings, as long as they are profitable, shows a stable base for a company to ward off the effects of a single product becoming unprofitable.

Product Risk Management

The CME Group Risk Management Handbook: Products and Applications (Wiley Finance)

Praise for The CME Group Risk Management Handbook"Wow! The CME Group Risk Management Handbook is a 'ten strike' and long overdue. A must-read and reference for the risk ...

$95.00  $53.33

View on Amazon

Clientèle Risk

Is the company reliant on one or two large customers?

As with products, the risk of reliance on a single client to bring profitability, is a warning signal. Any client that has the power to make or break a supplier will likely take advantage of the situation.

It is not just the risk that the client will cease trading, but also the fact that they may decide to squeeze the margins and hold out for better pricing structures. Both of these are risk factors that you should determine and include in your risk assessment before going ahead with an investment.

What if the client went bust, owing substantial amounts to the company? The profitability of the company could be put in jeopardy. 

Customer Demands

Your Customer Rules!: Delivering the Me2B Experiences That Today?s Customers Demand

What you need to know about your customers Now more than ever, every interaction you have with customers is critical. Customers today have unlimited information at their fingert...

$28.00  $11.69

View on Amazon

Supplier Risk

Will the company be affected negatively if their suppliers increase prices?

Reliance on a single supplier is also risky. 

What if that supplier finds another client to supply? Either the company will need to find another supplier or they will have to compete on the price they are willing to pay for the supplies.

What if the supplier goes bust? The company would need to find an alternative, quickly. And the new supplier may charge higher prices because their competition is less.

What if the supplies deteriorate in quality? Without a back-up plan the quality of product from the company could also be affected.

Each is a factor in determining supplier risk.

Supply Chain Management

Guide to Supply Chain Management: How Getting it Right Boosts Corporate Performance (Economist ...

Getting the supply chain right can make the difference between a market leader and an also-ran. Globalization, technology, and an increasingly competitive business environment ...

$29.95  $19.86

View on Amazon

Workforce Risk

Is the workforce flexible enough to meet changing circumstances?

Workforce risk is a little harder to determine, but there are ways.

The best way is to keep your ears open and your eyes fixed on any news that may relate to any company workforce. 

Are the Unions resisting changes in working practices? Does the management need further flexibility to keep ahead of its competitors?

It is a matter of determining whether one or other of the companies within a sector has a more or less flexible workforce. The one with greater flexibility has a better chance of being the investment you make, all other things being equal.

Workforce Flexibility

Workplace Flexibility: Realigning 20th-century Jobs for a 21st-century Workforce

Although today's family has changed, the workplace has not--and the resulting one-size-fits-all workplace has become profoundly mismatched to the needs of an increasingly ...

$27.95  $1.95

View on Amazon

Risk Of Inflexibility

Can the company itself change to meet a new sales environment?

Things change constantly. Company management techniques and methods must change to take advantage of any new environmental factor. Stand still and die.

Inflexibility can take a stranglehold on a business. 

Assess how flexible your target investment can be and reference that against the flexibility of others. The more flexible the company, the better it will be at harnessing any new factors that affect its market share, or its ability to compete in its market.

Business Flexibility And Repeatability

Repeatability: Build Enduring Businesses for a World of Constant Change

An argument for simplicity from the bestselling authors of Profit from the CoreIs radical reinvention the key to winning in today’s fast-paced world? Not judging by the ...

$30.00  $9.09

View on Amazon

Next Investment Article

Gearing is the use of debt (borrowed money) to increase your risk and potential reward. If you own property you have used gearing.

Conclusion

Whether it be workforce, management, products, clients or suppliers, each has an effect on a company. These risks and benefits, once analysed, are determinants in your decision to invest, or not, to strengthen your equity portfolio.

Updated: 03/19/2012, humagaia
 
Thank you! Would you like to post a comment now?
0

Comments


   Login

You might also like

July 15th 2013 The Hostess Twinkie Makes The Sweetest Comeback...

Hostess will be back and the stock and on your local store shelves this July ...

Investment vs Speculation: Speculate To Accumulate?

Investment vs speculation is a long running argument. Do we really need to sp...


Disclosure: This page generates income for authors based on affiliate relationships with our partners, including Amazon, Google and others.
Loading ...
Error!